By the end of this chapter you
should have a basic understanding of the most important instrument in the
Coming together, like blades
of scissors, demand and supply determine market equilibrium. At
market equilibrium the quantity that consumers freely and willingly demand
at the market price is exactly equal to the quantity that producers freely
and willingly bring to market at that price. There is neither excess
demand (shortage) or excess supply (glut) on the market.
What is bought in a market
must be equal to what is sold. This is a truism that must hold. Market
equilibrium means more that. It indicates that the amount consumers want
to buy at the market price is exactly equal to what producers want
to sell at the same market price.
It is important that you
understand the concept of equilibrium in economics. Equilibrium is neither
intrinsically good nor bad. An equilibrium exists when opposing forces
just offset each other. Consequently, if an economy or a market is at
equilibrium it will tend to stay there. Typical, equilibria in economics
are stable equilibria, meaning that if the system is in disequilibrium
there are forces that tend to push it back to equilibrium.
If a goods market is in
disequilibrium, price should be either rising or falling. When the
quantity demanded exceeds the quantity supplied there will be excess
demand and the market price will rise. It is the rise in the
price that then eliminates the excess demand and brings the quantity
demanded into equality with the quantity supplied. As market price rises
the quantity demanded decreases as consumers substitute other goods for
this one. In addition, as market price rises producers decide to bring
additional quantities to market. These processes will continue until the
excess demand is eliminated.
When the quantity supplied
exceeds the quantity demanded, then there will be excess
supply in the market. At the current market price, some
suppliers will be unable to sell all of there output. This should put
downward pressure on market price. Price should continue to fall until the
excess supply is eliminated and the quantity demand exactly equals the
If you are unsure about these
concepts you can try a short quiz at the University of Omaha by Kim Sosin.